Up Over 56%, Is Toyota Overvalued?

Toyota (NYSE:TM) has surprised many investors over the past year, with shares rising by 56.5%.

Riding a wave of enthusiasm for Japanese economic growth and its own successes, Toyota has risen to new highs.

The question is whether investors have taken the stock too high or if there’s still room left for growth at this legacy automaker.

Strong Earnings & Revenue Growth 

One of the most notable aspects of Toyota is its current performance in a difficult vehicle market.

For the first nine months of its current fiscal year, TM reported revenue growth of 23.9% and net income growth of 105.3%. These results have been in large part responsible for the stock’s upswing over the past year.

Toyota also benefits from both large, established revenue streams and attractive profit margins. In the trailing 12-month period, Toyota’s sales have amounted to $275 billion, while net profit margin averaged 10.2%.

Here, it’s worth noting that other auto majors have struggled to achieve similar levels of profitability. Ford, for instance, has maintained a net margin of just 2.5% over the same period.

Even better for investors is the forward outlook for Toyota. The company is expected to average an earnings growth rate of about 29% over the coming five years, and revenues are projected to grow by a further 8% in the year ahead.

Toyota’s EVs Could Lead the Field

While Toyota has been slow to get into the EV field, the company finally announced a major move into electrics late in 2023.

Toyota’s competitive model, it seems, will be centered around battery innovation. The company plans to introduce long-range batteries capable of powering vehicles for up to 500 miles by 2026. For reference, Tesla’s Model S gets a comparatively modest 405 miles to a charge.

An even bigger disruption could come as early as 2027, when Toyota says it will roll out vehicles equipped with solid-state batteries (SSBs). This type of battery offers even better energy density and faster charging times, making it a natural successor to the current field of lithium-ion batteries. With SSBs, Toyota believes it could push ranges to as high as 620 miles.

By 2030, the company plans to sell up to 3.5 million EVs per year. With Toyota’s experience in manufacturing, excellent engineering capabilities and the highest brand loyalty rate among American car buyers, the company could position itself as a leader in EVs by the end of this decade.

Tailwind From a Resurgent Japanese Economy

A final reason to like Toyota right now is the general improvement in Japan’s economy that has taken place post-2020-21 shutdowns. Prices and wages are rising at a meaningful pace for the first time in years, and the country’s businesses are beginning to grow and innovate as consumer demand strengthens.

Although it’s still not certain that this phenomenon will turn into a long-term growth trend, bullish sentiment on Japan is at its highest point in decades. Even Warren Buffett, famously averse to investing outside of America, has made a series of investments in Japanese finance companies on the basis of general economic growth in the country.

For Toyota, an improving domestic economy offers many benefits. In addition to more interest from foreign investors, a stronger Japanese outlook also means more sales for the auto giant.

Toyota is far and away the largest car brand in Japan, with annual sales more than doubling those of second-placed Suzuki. As Japanese consumer confidence rises, Toyota will likely see stronger sales in its own domestic market.

Is Toyota Stock Overvalued?

According to 4 analysts, Toyota stock is 18.7% overvalued at this time with fair value at $190.30 per share.

Some researchers, however, think Toyota may have a little more gas in the tank when its growth prospects and the resurgence of the Japanese market are taken into account.

Shares trade at 11.3x forward earnings and about 1.0x sales. Even more attractive is the price-to-earnings-growth ratio of 0.5, which is an indicator of undervaluation relative to growth.

The counterargument to this value case is the fact that Toyota’s rising share prices may have already taken it close to its intrinsic value.

In the short term, analysts certainly appear to believe that this is the case. Over a longer time frame, though, Toyota’s growth has the potential to support higher prices. It appears that Toyota could be an attractive company trading at a fair price and arguably needs to pullback to make for a more compelling investment case.

Expectations Are Sky High

Can Toyota live up to the expectations it has set as it invests in EV production. Tesla and other automakers already have leads on the company, making it essential for Toyota to make good on the promises of its new long-range batteries.

If the company falters in executing its EV growth strategy, shares could retreat as investor enthusiasm dwindles. Though Toyota doesn’t trade at anywhere near the multiples of EV startups, it may be subject to the same dynamics that drive electric vehicle hype elsewhere in the market.

Like other EV makers, Toyota will also be exposed to competition from China. Elon Musk recently stated his belief that Chinese EV makers would dominate the market unless trade barriers were established. Toyota’s strategy of investing in EVs while continuing to manufacture more traditional vehicles could insulate it more than a pure electric company like Tesla, but building pressure from China will still likely affect it.

Is Toyota a Buy Now?

With the recent spike in Toyota’s share prices, investors may be concerned that the stock has become too expensive. 

Short-term analysts do forecast a pullback in shares, though it appears on a longer time horizon that there is still plenty of room left for Toyota to reward shareholders.

Technically, the share price is overbought now so the reward to risk ratio at this time is not favorable when viewed through the lens of a chart analyst.

With the new electric rollout not starting until 2026, it will be a while before the company’s growth initiatives can show up in its financial results. Until then, the legacy vehicle business will likely continue to perform fairly well without producing explosive growth. This caveat aside, Toyota looks like a potentially strong buy for patient value and growth investors.

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